March: The Trick to Making Money in Financials This Year
"Does this mean we don't need Visa?" - our stablecoin future, Looking at DC banks; Three banks trying to make it; GBank's payments software in detail; Ed Barry interview at Capital Bank in DC.
Our 1Q gift went to Glenwood, a campus for autistic children and adults who need support for daily living. Thanks to paid subscribers for supporting these charities. This note will continue to focus on value-add single stock situations in the paid portion for this reason.
In this note, 5 Point is 7 Points this month:
Stablecoins are coming. They seem like a positive for banks.
A test of intelligence for financial sector investing in 2025
Can they make it out alive? A look at Patriot (PNBK), U&I (UNIF), and Varo.
Why don’t some cheap Korean-american banks repurchase shares?
The DC Banks, and the hidden DC Banks: We look at some you probably know, and others you might not think of.
A followup on what supports GBank (GBFH) valuation: the detail behind the bank’s payments technology for deposit-gathering.
An interview with Ed Barry, CEO of Capital Bank (CBNK), a high-performing bank just outside DC in Rockville, Maryland. A long-term Colarion holding, Capital runs several differentiated verticals including PAC deposits, cash-secured cards, a USDA lending division, and an SBA servicing business among others. CBNK Shares have tripled over the past 5 years and tangible book value has doubled.
On to the notes:
1) Bank-Issued Stablecoins look to be in our future. What it means for banks and non-banks.
Currently Congress is sorting through two draft bills, the GENIUS Act in the Senate and the STABLE Act in the House, each to establish a regulatory framework for stablecoin issuance and “advance the President’s mission to make America the world capital of crypto.”
The way I interpret the GENIUS act’s 57 pages, linked above:
You need to be a regulated by Fed, OCC or FDIC to issue a stablecoin.
You can back the coin with cash, segregated deposits, or treasuries. You cannot commingle assets backing the coin, so this acts like Customers Bank’s CBIT deposits where the bank sets aside cash for 15% of deposits for crypto customers and just earns the spread while paying depositors nothing, or even charging fees at times.
You have to publish what backs the coin monthly.
Noticing this, Bank of America CEO Moynihan told the Economic Club of Washington last week that if stablecoins were legalized and approved for banks, then his company would be launching one.
Below are some possible changes from stablecoin payments inside and between banks, from my early-stage perspective:
Disruptive of Unregulated Coins: First, note again that the bill does not provide for unregulated stablecoin issuers. You can be a “nonbank”, but you would still regulated by the OCC, which would be interesting. Perhaps entities like Paxos could do that. However I expect Tether, the “preferred choice for crime syndicates”, would need special Mar-a Lago approvals to get through.
Also, if you have a coin inside a bank, why bother with Tether, Paxos et al? Perhaps for international transactions or crypto speculation, but then again the OCC would be watching, so it seems Congress is nudging marketshare to banks.
Convenience: Stablecoins ideally will allow us to transfer substantial funds domestically, quickly, with some button clicks vs the slow manual processes we deal with now.
It seems perfect for business payments and to replace wires and FedNow. But what about smaller transactions? This raises the question of…
Retail Disruption: Do we still need Visa? A great question, that probably depends on how easy banks make it to use, and how aggressively Visa pursues the field of play relative to actors like Moynihan. I would think that if the merchant has a bank, and you have a bank, and the interface is easy, this could take share from the rails. Initially though, it may be most popular for remittances and corporate treasury.
Further, banks don’t always make it easy - market share at Zelle is small. Also, a blockchain entry for low dollar retail transactions may be difficult, because it is permanent.
Finally, throughout the evolution of this process, we can’t underestimate the power of the pools of money that Visa, Tether and others will use to influence anything disrupting their model. Donor money is respected at Mar a Lago.
I suspect Visa is safe for a while.
New demand for treasuries. Today, large banks own treasuries for liquidity requirements and to support capital markets activities but small banks have little need for them. In a stablecoin world, all banks would want treasuries to support coins, unless they already run low loan / deposit ratios.
Can create low(er) cost deposits for banks. I say this with the assumption that competition allows banks to pay no interest on the coins and the coins become popular. Again, I think of the Customers Bank paradigm.
Can bring deposits in from Paypal, Venmo, Tether, Paxos and other nonbank sources, to the degree the banks provide FDIC coverage, better rates, or greater convenience. They probably will provide at least two of those.
Some drawbacks of this envisioned system:
Maybe nobody cares for a while. Did you know Paypal had a stablecoin? Probably not, because nobody cares yet.
Who uses what coin? Bank of America can issue its own stablecoin without a problem. Do JP Morgan customers want or get to use that? What about Southern States Bank of Anniston, Alabama? Do they join a cooperative, or just lose on the opportunity? Right now small banks have to pay a toll of sorts to access Zelle, because processors like Jack Henry charge a hefty fee for use. Hopefully the issuance can benefit more than just large banks, and a common coin can be established.
Stablecoins can accelerate a run on a bank. No lines, no waiting! First Republic was protected by operating hours and wire delays. Even realtime Fednow has $500k / $1mln limits. Would stablecoins have brakes?
Reversing mistakes. It’s impossible to reverse a blockchain transaction, so if you are Citi and you accidentally send $81 trillion to someone, the recipient will probably initiate a transaction back to you given that money doesn’t actually exist, but everyday fraud will become permanent.
Before we move on, I’m sure there are other angles on this important topic and I will likely do a follow up discussion in a future edition. Your comments on elements that I missed are helpful. Travillian has an informed interview video on coins as well.
2) A test of intelligence, to invest well in financials this year
“The test of a first-rate intelligence is the ability to hold two opposed ideas in mind at the same time and still retain the ability to function.” - Scott Fitzgerald
In that light, consider two ideas:
Idea 1: The macro backdrop can bring downside volatility to markets, from changes in fiscal / employment and trade. (Steve Cohen with hair gave perspective at the 15 minute mark here)
Idea 2: Banks can do relatively well nonetheless, because of rising spread.
The rising spread comes from this:
As an example of the spread opportunity, American Business Bank in Los Angeles (AMBZ) is putting on business at around a 5.8% spread while it reported a 4Q margin of 3.28%. American is dragging some legacy assets that are gradually running off. In that same 4Q release the bank noted that December margin was 3.4%. Maybe 1Q margin will be 3.5%? Will year-end margin approach 4%? Not a bad trend.
This is the magic of an upward sloping yield curve for banks with good deposits and lots of fixed rate loans - almost guaranteed sustained sharp earnings growth just from running in place.
At the moment AMBZ nonetheless trades around 8x the lagging, “pre-expansion” 4Q earnings power. Investors can also consider the impact from balance sheet growth and share repurchase.
Finally, AMBZ has a strong history on credit which is obviously important if employment and growth are pressured.
Among others, John Marshall (JMSB) is a particular beneficiary of this margin trend, as is Bridgewater (BWB) in Minnesota, WTB of Washington (WTBFB), Ledyard (LFGP) or Southern First (SFST) in South Carolina.
Below is a simple screen of banks ranked by recent margin growth. A column to the right of that shows the change in that bank’s margin from 2Q22, early in the last rate cycle.
Some in bold have margins below 2022 levels but recent rising trend, and are working looking more closely at. Many beneficiaries are poorly managed so be mindful in sorting through them. For example I have owned SLRK and CLST in the past but am not tempted today.
“But Sam, banks are toast in a Trump recession, due to credit”. Maybe some banks (see the next topic), but a long-time theme of this note is that credit risk has been migrating to funds. We shall see.
3) Lessons from ships that ran aground in calm water - survival chances at Patriot Bank (PNBK), U&I Bank (UNIF), and Varo.
Like fans attending a Nascar race in hopes of a crash, bank investors look in fascination whenever action heats up around distressed banks. Today, three $500mln+ banks are currently struggling to make it through.
- Patriot Bank (PNBK) is a $1bn bank along coastal Connecticut. It recently cost 350% to borrow a few thousand shares of Patriot at $1, so the market has made its decision.
However Patriot introduced Steven Sugarman as President in January of this year to help with a capital raise, and has a term sheet along with its recent consent order deadline to achieve a 10% capital ratio.
Sugarman is highly connected and likely has access to institutional funding, although it’s the same Sugarman who ran Banc of California from 2012 to 2017 and ended up leaving.
Back to Patriot, the company shared its written agreement with the OCC on January 14. It read like the bank is doing almost everything wrong. “The Comptroller of the Currency (“Comptroller”) has found unsafe or unsound practices, and violations of law, rule, or regulation, including those relating to strategic planning, capital planning, Bank Secrecy Act/Anti-Money Laundering (“BSA/AML”) risk management, payment activities oversight, credit administration, and concentrations risk management.” OCC asked them to shore up their capital by Feb 28. Is that a suggestion and not a deadline?
PNBK has $1bn in assets, $34 million in capital, lost $26mln in 3Q and $9mln in 4Q leaving $1.07 per share of forecast book value at the holding company. The bank will be pressed to make much profit with a 2.3% margin and the regulators pushing them to spend heavily to fix the bank.
I figured Patriot would need $75mln+ but the company has shared that it has a term sheet at $0.75 / share plus preferred, for $60mln. Someone is going to get 7 branches along the CT coast. It would be a pleasant surprise if the $0.75 goes through and Patriot can raise at a positive value for legacy equity holders. I emphasize the word surprise, because $0.75 is 70% of book and you can easily find healthy banks cheaper, but perhaps Sugarman is desperate for a rollup vehicle.
- U&I (UNIF) is a $500mln Seattle bank run for a Korean-American customer segment.
U&I went into year end 2023 with $80mln in capital, but was holding about $50mln of charge off content from an equipment finance business, which they would run through the income statement from 4Q23 to 4Q24 in a process that also generated a tax allowance hit that left U&I with $29mln of equity after adding back pre-provision earnings for the year.
Interesting, U&I trades today around 70% of book.
Why 70% and not 20%? Although the bank is going to make little money for some time and would do well to receive a capital injection, U&I has been lucky in two respects:
a) It happened to employ a Wharton MBA who agreed to step in as CEO.
b) Noted activist Joe Stilwell has a large investment in the bank and wants to see recovery and profit.
So while I view U&I as for “U not me” for now, this bank looks likely to be cleaned up over the next two years and sold alive. An acquirer could be a bank like George Guarini’s Bay Commercial (BCML), which has been known to promise “double dips” to low-multiple targets.
- Varo Bank is private, and has been through enough already without me piling on. Varo runs / ran a model trying to collect interchange fees in debit card swipes from customers of their online bank. But running a deposit-first bank with heavy activity and low balances is hard to pull off. There is a reason large banks charge fees for low balances. Varo avoids fees but spends heavily on processing, marketing, and people and has an average deposit balance of only around $65.
Varo hopes interchange can be enough. I have added perspective in their FAQ page given current trends.
I’m not scribbling in crayon that Varo will fail, just that the current business model does not sustain.
Varo is down to a few more quarters worth of historically typical $10mln+ quarterly losses before severe issues. Varo’s CEO has resigned and the bank is trying to raise capital again. Retained earnings are gravitating to negative $800 million because of the model:
This bank that has raised $950 from TPG, Warbug Pincus, Blackrock, Lone Pine, Russell Westbrook, and Acuity Partners among others. The best choice would have been to have sold in 2022 to a financial buyer for a discount to book. The second best choice would be to sell to a financial buyer today. As of today investors as a group can hope to recoup about 7 cents on the dollar and ultimately that number may go below a nickel. They really should focus to keep it above zero because I’m not sure how the model profitably transforms.